• Embed Doc
  • Copy Link
  • Readcast
  • Collections
  • 2
    CommentGo Back
Download
 
261
7800B
ANKRUPTCY
P
ROCEEDINGS
Francisco Cabrillo
Professor of EconomicsUniversidad Complutense de Madrid 
Ben W.F. Depoorter
 Researcher University of Ghent, Faculty of Law
© Copyright 1999 Francisco Cabrillo and Ben Depoorter
Abstract
Bankruptcy has become a crucial legal institution in market economies allover the world. We try to explain some aspects of bankruptcy law anddiscover that economic theory provides explanation for many, but not all,attributes of bankruptcy law. Both legal and economic scholars have beenengaged in a long series of discussions on the meaning of these attributes.
 JEL classification
: K22, K40
Keywords
: Bankruptcy, Liquidation, Reorganization
1. Introduction
The word ‘bankruptcy’ originates from the Italian word ‘banca rotta’, an oldexpression that indicated that the bench of a trader was broken when he wasnot able to pay his creditors. For a long time bankruptcy has been animportant legal institution in market economies. It enables the marketsystem to dispose of inefficient firms and reallocate the assets of insolventdebtors. Also, the possibility of becoming bankrupt has been considered tobe a positive incentive for behaving in an efficient way, both for individualtraders and company managers.Bankruptcy law has traditionally been researched by lawyers, noteconomists. But in the last two decades many studies on the economics of bankruptcy proceedings have been published. Behind the technicalities of the legal regulation of bankruptcy lies a clear economic rationality.
 
At theorigin of a bankruptcy proceeding there is a financial crisis of an individualor company. Economists analyze bankruptcy law as the legal instrument toachieve the best possible outcome, which implies a minimization of 
 
socialcosts. Traditional legal theory, however, usually focuses its analysis on the
 
262
 Bankruptcy Proceedings
7800fairness and equity aspects of bankruptcy. From a law and economicsperspective the efficiency of the bankruptcy procedures are the core of theanalysis.Bankruptcy law, as it exists in most countries, can also be understood asa device to increase the efficiency of commercial relationships. In anycontract the parties could introduce clauses regulating what should happenin case of default and how the assets of the bankrupt company should bemanaged. However, the transaction costs of writing and implementing suchcontracts would be very high. And, since a firm’s balance sheet is somethingdynamic that changes every day, creditors would be forced to renegotiatetheir contracts every time new creditors make claims against the debtor’sestate or every time the debtor acquires new assets or pays his previousdebts. Therefore, it may be considered efficient to have standard proceduresregulating the possible outcomes of a firm’s default (see Aghion, Hart andMoore, 1992).This chapter studies the efficiency of the most relevant aspects of bankruptcy law. Although most
 
bankruptcy codes share many characteristicsin their way of dealing with bankruptcy
 
proceedings, each legal system hasits own peculiarities and no international economic organization has yetbeen able to draft an international bankruptcy code. Therefore, this chapterwill not focus on any specific national bankruptcy law, but rather willdiscuss the most relevant general issues while occasionally commenting onsome particular national institutions. Also, our main attention will go tobusiness bankruptcy. The issue of personal bankruptcy is touchedsporadically, for example in the discussion on discharge in Section 3 (formore on personal bankruptcy, see Apilado, Dauton and Smith, 1978; Shiersand Williamson, 1987;
 
Warren, Sullivan and Westbrook, 1988, 1989,1994a).The second section of this chapter presents bankruptcy proceedings as acollective action of creditors to recover their credits in the most efficientway. In Sections 3 and 4 the main objectives of bankruptcy and the mostrelevant costs of a liquidation proceeding are discussed.
 
Sections 5, 6, 7 and8 deal with some of the economic agents involved in bankruptcyproceedings: the debtor, the creditors and employees. A specific section isdevoted to the role of employees as a special type of 
 
creditor. Theliquidation-reorganization dilemma is discussed in Sections 9 and 10. Thefinal section comments on the possible alternatives to the existingbankruptcy proceedings. The problems of secured credits and bankruptcypriority rights will be taken into account occasionally; they are treatedelsewehere in Volume II (Chapter 1500, Security Interests, Creditors’Priorities and Bankruptcy) and in Volume III (Chapter 5660, Regulation of the Securities Market).
 
7800
 Bankruptcy Proceedings
263
2. The Collective Action of Creditors
The meeting of creditors, in most bankruptcy legislation a prerequisitebefore adopting any final decision concerning the bankrupt firm, may be agood example of the various efficiency aspects in bankruptcy procedure.From a
 
law and economics perspective this compulsory meeting can beunderstood as a useful means to reduce transaction costs in collective action.Negotiations between various creditors are often difficult and expensive.Although an agreement is certainly not guaranteed in this meeting,procedure costs may be substantially reduced.In more general terms, bankruptcy law can be defined as a set of rulesthat institutionalizes collective action in debt collection (Jackson, 1986a).When collecting their credits out of a bankruptcy procedure creditors play anon-cooperative game, in which each individual maximizing strategyproduces an inefficient outcome. Social costs will increase when eachcreditor tries to get the highest possible percentage of his credit. Theseindividual strategies cannot raise the value of the debtor’s estate. On thecontrary, they reduce the net value of the assets to be distributed among thecreditors will be reduced. However, the principle of collective action seemsto conflict with another generally accepted principle of 
 
bankruptcy law, theexistence of secured credit, and the principle according to which bankruptcylaw should not change the previous structure of the debtor’s liabilities.An important characteristic of some secured credits - mortgages, forinstance - is that creditors can sell off part of the company’s assets, asidefrom the normal bankruptcy proceedings, in order to collect their creditsbeforehand. This possibility not only breaks the principle of collective action- such secured creditors are usually not interested in what may happen toother creditors - but may also reduce the net value of the bankrupt companybecause of piecemeal liquidation.The possible conflict of these two principles should be one of the basicproblems to be discussed by any economic analysis of bankruptcy law. Mostlawyers and economists acknowledge the existence of such a conflict.Bankruptcy law should offer a solution. In some cases collaterals can besubstracted from the assets to be distributed and secured creditors denied thevote in the bankruptcy proceedings. In other cases bankruptcy law canprovide the receiver or the administrator the option of paying secured creditsby selling assets if the goods given as collateral are considered to be essentialfor an efficient reorganization or for selling the company as a going concern.The existence of secured credits does not mean, therefore, that the principleof collective action has to be abandoned.
of 00

Leave a Comment

You must be to leave a comment.
Submit
Characters: ...
05 / 01 / 2011<span class="translation_missing">en_US, this_document_made_it_onto_the</span>Rising List!
You must be to leave a comment.
Submit
Characters: ...